Oracle Stumbles but Deserves Forgiveness

I asked recently if Oracle can hold its momentum. After all, the stock had been on a considerable run of more than 40% since last year. Plus, with the recent acquisition of Acme Packet , there seemed to be nothing standing in the way of the database giant from further gains. However, after disappointed third-quarter results, which sent the stock tumbling down 8%, I got my answer.

Are we getting carried away?In my recent article, which previewed Oracle's earnings results, the Street missed the part where I warned investors of potential seasonality-related weaknesses in this quarter. I said:

We can make all of the predictions we want about earnings. Whether or not Oracle beats estimates or produces results that arrives in line with expectations, everything will hinge on how the company guides for the rest of the year and possibly fiscal 2014. I say this to caution investors to not be so focused on what the company reports this quarter.

Nevertheless, management guided for Q3 earnings per share of $0.64 to $0.68 -- slightly higher than $0.62 per share earned a year ago. Revenue growth is projected to come in the area of 1% to 5% -- ranging from $9.1 to $9.5 billion. Although these are not breathtaking projections, investors have to keep in mind that Oracle has not posted historically strong seasonal Q3 numbers.

The stock's punishment is a gross overreaction. And as I've said before, it's a mistake to judge a company like Oracle on a per-quarter basis. Given Oracle's recent moves into the enterprise and the cloud, the real story is about where the company is heading, not where it is today.

Is there legitimate cause for concern?At first glance, I can see why investors got spooked. Aside from missing both top- and bottom-line estimates, the degree of the miss was pretty significant. With revenue arriving more than 4% below estimates, this was the company's worst miss in almost two years. However, management didn't seem all that concerned about the business. Sales execution, however, was another issue.

Revenue arrived at $8.9 billion, representing a 1% drop year over year and falling short of Street targets of $9.38 billion. Management said that the decline was due to a "lack of urgency" within its sales force, particularly from those that were newly hired. Still, it doesn't help knowing that chief rival salesforce.comjust posted sales of $835 million, which beat consensus estimates of $830 million.

However, this isn't something that would concern me. For Oracle, the weak sales execution just means that revenue is being pushed out farther than expected. It's not a signal of loss of market share. Again, I pointed out earlier that Q3 is typically Oracle's slowest quarter. And investors should expect these sales delays to be closed in the Q4 report, a notion that management agreed with.

Besides, it didn't affect profitability by much. Net income still arrived at $2.5 billion, or $0.52 per share. Excluding items, earnings rose to $0.65 per share. However, if investors should have a legitimate gripe about anything, it's that software and cloud subscription revenue declined 2%. This is the barometer that tracks how well Oracle is doing against salesforce.com and SAP in that all-important software-as-a-service, or SaaS, category.

Management has to do better here, because not only do software sales generate high margins, but they also provide long-term maintenance contracts, which is an important gauge of future profitability. So the 2% decline was glaring, especially since the company had forecasted growth of 3% to 13%. And when compared with Q2, during which Oracle posted 17%, which (then) topped management's own bullish projections, eyebrows have to be raised.

Time to regroupAll of that said, I'm still positive about Oracle's prospects for the next quarter, especially since corporate enterprises will have more clarity about government spending. And it certainly didn't help Oracle that the last day of the sequester fell into the third quarter, either. Nevertheless, Salesforce and IBM are also waiting for those dollars to start flowing in, which means that Oracle needs to differentiate itself better to win more business.

The good news, though, is that Oracle is now able to better leverage its cloud portfolio against the competition. With Acme Packet's product portfolio, which includes the Net-Net line of devices, Oracle now has a one-stop-shop advantage that neither IBM nor Salesforce can duplicate. And investors shouldn't ignore how cheap the stock is now, at $32.

With 2013 earnings estimates being $2.69 per share, the stock is now trading at a P/E of just 12, or 6 below the S&P 500 average of stocks in Oracle's category. In a market where stocks often take off and never look back, Oracle is now giving opportunistic investors a second change to buy. At this level, it's too good of a deal to pass up.

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